Portfolio manager Cale Smith’s riffs on investing, spoke funds, and Islamorada in the Florida Keys.

Moving right along on our series on the contrarian financial planning book Spend Til The End. This is the second part of the third section, beginning with the 17th chapter. From the 25th latitude. In my flip flops.

Chapter 17: Cashing Out

The conventional wisdom says to delay withdrawing from your 401(k) to defer taxes as long as possible and to take your Social Security benefits as soon as possible, so you don’t die before fully using them. But can you ever realistically predict your life expectancy? In addition to planning for an earlier than expected demise, it may be smart to plan for living too long as well.

So when should you withdraw from your 401(k) and take Social Security? Consider a 62 year-old childless retired couple with $500K in regular assets and $250K each in 401(k) accounts. Contrary to conventional wisdom, their best option is actually waiting until they’re 67 to withdraw from the 401(k) plan and to wait until age 70 to take Social Security. This option allows the couple to increase their living standard by almost 13%. Why the huge difference? Because each year you delay collecting Social Security, it’s increased by approximately 7%, adjusted for inflation. If our couple started their retirement account withdrawals before the age of 67, they would pay a lot more in taxes and simply be worse off.

How long you can wait to collect those assets largely depends on the assets you can use prior to retirement. If you are asset-light, then taking 401(k) withdrawals between the ages of 62 and 69 is probably your best bet. If you want to leave money to your kids, it’s best to give it to them now or buy life insurance to give them the inheritance you want – instead of taking Social Security early just to leave them money in the event you die early.

Chapter 18: Double Dip on Social Security

Little known fact: you can receive more than one type of Social Security benefit, or be paid the same benefits more than once.

Let’s focus on the first option. Consider Bill and Hillary, a 62 year old couple where Hillary is the bread winner and a lucrative lawyer while Bill plays sudoku all day. Bill is entitled to both spousal and survivor benefits based on Hillary’s earnings. These benefits will not impact the choices around collecting his own retirement benefits because he is not trying to collect both spousal and survivor benefits at the same time. If he does try to collect both at the same time, he will only get the larger of the two.

Bill’s best option is to collect his own retirement benefits of around $7,000 for each of the next four years until the age of 66 after which he can collect spousal benefits of $13,305 – even if Hillary hasn’t begun collecting hers. By taking his retirement benefits first and spousal and survivor benefits later, Bill receives $28K between the ages of 62 and 66.

Now let’s consider the second option. Did you know you can apply for Social Security early, then repay the amount taken without interest or adjustment for inflation, and then reapply again later? Say hello to Form 521, Request for Withdrawal of Application.

If you have begun taking your Social Security early, but then read Chapter 17 above and realized the benefits of deferring your Social Security, you can still correct the situation with a Form 521 and improve your living standard. And reapplying for Social Security is still a good option even after having paid federal taxes because the IRS allows you to recover these taxes by taking a deduction or credit.

Chapter 19: Russian Roulette for Keeps

Note: I expected more railing against annuities in this chapter but got very little. It concerned me that the only warning given to readers about the downsides of annuities was two tepid sentences. The authors do come to a reasonable conclusion, though only after four pages of explaining how, in the economic sense, annuities in theory fill a valuable void.

In the end, the authors encourage the reader to think of annuities as “confiscatory Russian roulette” in which the firms who sell them take a hefty cut of the pot before handing out what’s left to the survivors. In the detachment only an economist can muster, it is cautioned, “the insurance industry isn’t offering actuarially fair deals, at least not at the moment.” Don’t hold your breath.

We are all at risk of outliving our savings, and the authors believe annuities can be quite important in raising a person’s living standard.

Let’s take an example of 65 year-old, single Sue Sanguine. Sue has $300K in each of three buckets – regular assets, regular IRA and home equity. She has invested all of her regular and retirement account assets in TIPs yielding 3% over and above inflation. Her only annuity is the $1,000 she receives every month from Social Security. Her annual expenses are $6K for housing and $1,122 for the Medicare Part B premium. Sue has correctly decided she can spend $28,643 annually based on the income she will get from the TIPs.

Sue leaves a lot of money up for grabs because she fails to annuitize her assets. Even if she lives until her maximum life expectancy of 100, Sue will leave behind $300K in home equity – assuming she doesn’t sell her house at all.

Sue’s retirement account assets currently give her only $13,969 annually. If she purchases an actuarially fair inflation protected annuity, she can spend $19,156 annually, which is 37.1% higher than the previous $13,969. If Sue were to annuitize her assets by taking a reverse mortgage on her house, she could raise her living standard by a whopping 50%. This would allow her to spend $42,947 annually instead of $28,643. Sue could further improve her living standard by waiting until the age of 70 to take Social Security, which would allow her to spend $44,625 annually.

The situation would change significantly if Sue had three children and wanted to leave them an inheritance. She could make an arrangement with her kids whereby they inherit her assets and they help her financially during her retirement, but the risk with this arrangement is that Sue’s kids could loose their jobs or run into a financial crisis, leaving them unable to help Sue.

After taking all of these risks into consideration, Sue could decide to pick from any of the following options:

1 – Give the kids whatever she wishes to leave them right now;
2 – Hold some cash in the event she chooses to live in a nursing home;
3 – Take out a reverse mortgage; and/or
4 – Use her retirement and regular asset accounts to buy annuities.

Bottom line: annuities can be useful, like reverse mortgages, but they should be considered carefully.

Chapter 20: Learning your B’s and D’s

Another way to control your benefits from the government is to decide whether and when to take Medicare Parts B and D. There are significant lifetime penalties for signing up late, and waiting to enroll makes sense only if you have extremely secure alternative coverage.

The premium amount rises with each passing year. The Part B (outpatient) premium rises by 10% each year you delay enrolling, while Part D (prescription drug) rises by 1% each month you wait to enroll.

If you have very reliable basic coverage which excludes prescription drugs from a previous employer, it makes sense to enroll in Medicare Parts A and D at the age of 65.

If you are extremely certain you’ll have complete coverage from a past employer, the best move is to completely avoid Medicare.

The last scenario is trickier. If you are 65 years old and intend to work two more years for an employer that covers everything, it still may make sense to enroll in both Medicare Parts B and D at age 65. You’ll have to pay quite large premiums for two years with no return, but after those years your annual premium payments will be more than one-fifth smaller for the rest of your life than they would otherwise be.

Chapter 21: Holding Your Nuts

Squirrels hoard nuts, we should hoard assets. Enough said about that title.

Investing in a tax-efficient manner is more important the higher your tax rate.

Equities held long-term are currently taxed at 15% or less, depending upon your income level, while interest earned on bonds is taxed as high as 35%. If you have both regular and retirement accounts and invest in stocks as well as bonds, your smartest move would be to shift all your stocks and other tax-favored assets (like tax free municipal bonds) into the regular asset accounts and move other taxable assets into the retirement accounts. This will help you increase your living standard due to tax breaks.

Chapter 22: Fire Your Broker

How to define most mutual fund managers: they systematically fail to do their job (i.e. they almost always fail to meet the market/index, let alone beat it) but still make a fortune and spend an extravagant amount of time playing golf with your corporate benefits people. For these services typical brokers and investment companies charge commissions or an annual flat fee of 2% a year. And 2% is significant. Assume your portfolio yields 5% after inflation, paying the manager 2% will shrink your annual returns by an astonishing 40%.

An easy way to maximize returns is to fire your broker and manage your own investments in the simplest and cheapest way possible: buying index funds. Using the same logic, your employer should fire your 401(k) plan manager. A Federal Thrift Savings plan with an annual cost of just 0.03 percent goes a long way towards enhancing your returns and standard of living. So if you don’t have them, badger your employer to offer hyper-low-cost index funds.

Chapter 23: Downsize

Reducing your off-the-top expenses like college tuition and housing – or cutting down on vacations and weddings and other non-routine expenses – can dramatically raise your living standard. Living in a lavish $3.5 million mansion that means spending $60K annually in property taxes could leave you with very little disposable income to spend during retirement. In such a situation, taking a reverse mortgage or moving to a less expensive home can dramatically increase your living standard.

In short, make sure you understand what cutting down on a few luxuries really means for your disposable income by calculating your living standard with and without them.

Chapter 24: Equitable Alimony

Divorce comes with heartache, but it could also come with a lower living standard if you don’t get a fair deal. Take Frank (45 years old) and Stacy (30 years old). They have two kids. Frank is a dentist making $150K annually from his practice which would sell for $300K, while Stacy is a dietitian making $30K per year. They own a $500K house with a $200K mortgage and have $500K in regular assets. In addition, Frank has $200K in his retirement plan.

The current settlement deal lets Stacy keep the house (along with the mortgage) and the regular assets along with $15K per year, per child, in child support from Frank. He keeps his practice and his retirement plan money. With this deal, Frank’s living standard will be $45,075 a year while Stacy’s will be half of Frank’s at $23,659 a year. If Stacy gets $10K alimony each year, Frank’s living standard would drop to $32,689 a year while Stacy’s rises slightly to $25,553 annually. They can both improve the situation by contributing to retirement accounts and delaying drawing down their social security benefits as well.

In a divorce you could spend years playing the blame game, but your time is much better spent by definitively determining how each party is treated in terms of what really matters: future living standards.

Next up – Part 4: Pricing Your Passions. I’ll be on the road again next week this time, so Book Notes will pick up again on July 9th.

The latest installment of our recent series, where we boil down others’ contrarian financial advice and let the dust settle where it may.

Part 3: Raising Your Living Standard

Lot of material here, so I will split it up into two parts. 3a is below and 3b will be next week.

Chapter 9: My Son, The Plumber

Who do you think has the higher lifetime living standard – doctor or plumber? You might be surprised. The authors run through a scenario, based on reasonably realistic assumptions, showing that over both lifetimes, a plumber’s standard of living could actually be higher than a doctor’s. After factoring in the cost of medical malpractice insurance, education, loan interest and a delayed start to prime earnings years compared to a plumber, who takes no loans and begins earning income even during his training, it’s at least closer than you might think…even if you find fault with a few of the assumptions.

Bottom line: don’t take your career for granted.

Also, don’t even bother trying to get a plumber to come over on a Saturday. And the PayScale.com site can be useful when figuring out what different careers pay in different areas.

Chapter 10: Does College Really Pay?

I’m keeping most of my notes from this section private, just so they can’t ever be used against me by daughters.

The real question while deciding to attend college is if a higher living standard is achieved over your lifetime given the costs associated with attending college (i.e. four years of tuition, room and food – and with no earnings coming in). Based on pure economics, going to an expensive college is far less beneficial than most people believe.

Chapter 11: Fire Your Job

Suppose you are married and both of you earn $17,500 or slightly over the minimum wage. If either one of you stopped working, you are actually more likely to raise your living standard. This is because (at the time the book was written) a combined household income of $35,000 disqualifies you from most tax credits and benefit programs like Medicaid. Reducing your income by half is more likely to enable you to qualify for all possible tax credits and benefits, and when combined with reduced taxes, your economic gain will likely be an amount close to the earnings you gave up.

The same logic applies to moderate and high income groups. If your earnings are towards the lower end of the tax bracket you fall in, it might make more sense to reduce your earnings to raise your living standard.

To be clear, the authors aren’t necessarily recommending this as a sound financial planning strategy (at least I don’t think they were) as much as they were highlighting this point: the government is guilty of malign neglect in determining the impact of a complex system of taxes and benefits on the work incentives of many Americans. In some cases people would actually have more spending power by not working. Nutty.

Moral of the story: knowing your effective tax bracket might help you easily raise your living standard.

Chapter 12: Location, Location

The following are the prices (pre-bubble, presumably) for similar houses in three very different locations:

Cedar Rapids, Iowa: $174,950
Tampa, Florida: $309,000
Seattle, Washington: $525,000

If you were a cold-blooded economist, in which home should you choose to live?

Yep. Living in Cedar Rapids raises your living standard 34% compared to Tampa and 78% compared to Seattle. That’s, um, kind of a big deal.

You could, however, argue that buying a house in Seattle or Tampa means leaving kids with higher assets or that it provides you with a safety net when it comes to paying medical bills. But if your kids get a better start in life, they are more likely to do better than you and may not require the assets at all. Besides, the major financial risk in your later years is nursing home expense rather than any illness. If you and/or your wife end up in a nursing home (one most likely to be covered by Medicaid), when the last spouse dies, most or all of your home equity will likely go to Uncle Sam, leaving your kids with nothing, anyways.

At this point I had to stop and give the kids the bad news. Then I made a margarita, went to the beach, and reminded myself why I don’t live in Cedar Rapids. Neither do the authors, by the way. So, again, might be another conclusion they made here that is more theoretically interesting than practically useful.

Chapter 13: Whether ‘Tis Wiser

Andrew and Jessica face a dilemna: to buy or rent a house in San Diego? Housing prices have fallen in the recent past but there could also be a sharp hike in the near future. (Reminder: this was written back when housing prices might actually go up again. Seriously. The authors were not drunk.) The same applies to mortgage interest rates.

Andrew and Jessica can never be sure of the correct time to buy a house. The most important consideration in buying a house is the certainty of living there for a very long time. If you are likely to move in the next five years, it’s not worth the risk.

Though renting the house rather than buying may look like greater savings, the opposite is true. Rather than renting, buying the house in San Diego leaves the couple with 4.6% higher living standard per year, despite the higher costs earlier. This is on account of the tax advantages of home ownership. Moreover, as time passes, the real value of mortgage payments fall due to inflation.

Another benefit is that if the house loses value, Andrew and Jessica’s living standard will increase rather than decrease. Why? Because of lower property taxes and subdued homeowner insurance premiums. Now the savings can be spent on things other than housing cost increases, although the net worth the two will leave to their kids will be lower. The opposite is true as well. If the value of their house rises, their living standard will take a hit, but the assets they leave for their kids will rise considerably. (Assuming they don’t end up in a nursing home, presumably.)

(Note: Unless your property taxes and insurance premiums are, in fact, lowered, this argument falls apart. I haven’t heard of any municipalities rolling recent property tax hikes back. And monkeys will fly before insurance companies lower premiums anytime soon.)

Bottom line: buying conveys lifetime tax breaks. It also entails higher short-term standard of living costs but lower long-term housing costs. But determining whether buying or renting offers the highest living standard for you requires careful analysis.

Chapter 14: Pay it Down, Way Down

To truly appreciate the winners and losers when it comes to the tax benefits of owning a home, we will consider three men – Armand, Bart and Chuck.

Armand makes $60,000 a year and has just bought a $180,000 house. Much to his sorrow, he learns that his first year tax savings from deducting mortgage interest is a miniscule $224. Also, his tax savings will disappear after the fifth year, leaving him with a cumulative tax benefit of $616. Due to these tax savings, his family’s living standard has improved only by a piddly 0.75%.

The societal benefit of the mortgage interest tax break is small because you only benefit if you itemize your deductions. A majority of low income households don’t.

Armand’s friend Bart makes $150,000 and has just bought a house for $400,000. The tax deduction for Bart and his wife is $4,098 in the first year and it continues for the next 25 years, making their total tax savings $64,092. The tax break effectively increases their living standard by 3.8%.

Chuck makes $400,000 a year and has bought a house for a whoping $1 million. Chuck and his wife enjoy a tax break of $18,821 annually for the next thirty years, raising their living standard by a handsome 45.1%. Now say his wife inherits $500 million dollars. Their smartest and safest option is paying off their mortgage, despite those tax savings. This is because Chuck would effectively save 2.5% in interest (assuming he pays 7% on the mortgage and earns 4.5% from interest on bond investments). Paying off his mortgage effectively increases his family’s living standard by 0.7% each year afterward.

In summary, those who really gain from deducting mortgage interest are the rich or upper class. The real tax advantage of home ownership has nothing to do with whether or not you have a mortgage on your home – it comes from not having to pay taxes on the rental income and services you earn and received on your house. (Economists call this implicit rent.) So, even those with no mortgage enjoy a tax break of sorts. The authors reiterate that paying off your mortgage is one of the smartest and safest investments you can make.

Chapter 15: Does it Pay to Play?

A simple way to raise your living standard is to proactively decide when and how much to pay in taxes. (Within bounds, of course.) Contributing to 401(k)s and IRAs allows you to postpone taxes, while contributing to Roth 401(k)s and Roth IRAs means you pay no tax on withdrawals, ever.

However, contributing to these plans is difficult for liquidity crunched households – and that represents about 2/3 of America. Making an effort to contribute could mean a significantly lower living standard in the present. For example, a 30 year old married couple earning $100K and contributing 6% until the age of 51 would see a 10.2% reduction in their living standard to get a 20.8% hike thereafter. The pinch in the short-run is big, but the long term gains are even bigger.

The best way to compare the returns of 401(k)s and Roth 401(k)s is to determine their impact on your long term living standard. Generally speaking, contributing to 401(k)s is slightly more beneficial than contributing to Roth 401(k)s, but there can be exceptions to this rule. If you are a 60 year old who is not borrowing-constrained, contributing to either plan gives you the same return; it provides an immediate 0.4% gain in living standard. Other exceptions may arise due to differences in age, earnings and marital status. Speaking purely in terms of net present value, however, at any age, everyone benefits from contributing to either of these 401(k) plans.

The other point to consider while looking at these plans is that money from Roth plans is completely tax free. With the exception of low income groups, contributing to Roth plans is safer as it protects you from tax hikes.

Figuring out whether to contribute to a regular 401(k) or IRA or their Roth counterparts can make you nuts. Ignoring future tax hikes, the regular route seems best – particularly for high earners. If tax hikes are on the way, though, the Roth makes more sense.

The authors give this advice (as they’re pretty confident tax hikes are coming): contribute to regular and Roth 401(k)s with a 40-60 split, but only after you’ve maximized your employer’s match. As explained previously, that match is free money, so even if you have to starve to contribute in an employer’s matching plan, it will be worth it.

Chapter 16: Converting

Conventional financial wisdom says its better to defer your taxes and earn interest on savings. Conventional wisdom also says it’s a bad idea to convert all your 401(k) or Traditional IRA money into a Roth IRA, since you would have to pay taxes immediately. However, the authors calculate that doing just that increases your living standard permanently by 5%.

Converting may allow you to take your 401(k)/Traditional IRA money out at a significantly lower tax bracket if you’re being hit by the AMT. Moreover, converting to a Roth before collecting Social Security reduces your taxable income and limits the taxes paid on Social Security benefits. These two benefits more than offset the gain of deferring taxes and earning interest on those savings.

Starting in 2010, anyone can convert their 401(k), regular IRA or comparable tax deferred retirement account money into a Roth IRA. That’s great news. However, converting is not necessarily a good idea for everyone.

A low income household, for example, will not pay taxes in retirement, so future tax rates don’t affect them at all and the need to convert is gone. Middle income households stand to reduce their living standard if their regular federal income tax rate is lower than the AMT rate (assuming the tax rates stay fixed). If the tax rates increase by 15%, then middle income households will see a 1.5% to 6% hike in their standard of living.

Obviously, future tax policy has a big impact on the benefits (or lack thereof) in converting to a Roth IRA.

That’s it for now. More Book Notes next week.

Notes from the second part of Spend ‘Til The End. Here’s what this is all about, and last week’s notes. Read Kirk’s comments on last week’s post for some thoughts from a fee-only advisor, too.

Part 2: Financial Pathology

Here’s how I would summarize this section on Twitter:

“Wall Street has your worst interests at heart. Prepare to be swindled. But if its any consolation, everyone else is financially clueless, 2.”

140 characters on the nose. Now I will let everyone know what I just fed my cat.

Chapter 6: What, Me Worry?

Most of us dislike thinking about retirement, so we rarely do. It’s just easier that way. Besides, we borrow far too much, far too often and far too long to ever manage to save anything for our retirement. Gambling is the fastest growing industry in America.

Note: this book was written back in the salad days – when the economy was actual growing.

The size of U.S. consumer debt (inclusive of credit card balances, car loans and mortgages) is approximately $12 trillion-with-a-T, or about $108,000 of debt per household. The risk in being unable to pay off this debt is higher for two income households. If one or both partners lose their income, that debt can’t be serviced and things go bad quickly.

One of the major causes of poverty in America is premature death.

This sounded to me like the opening line of a Stephen Colbert joke, but, alas, it was not to be. It turns out that death is, well, another uncomfortable topic to think about. The result is insufficient insurance for the primary breadwinner. His death commonly leaves the family with little to no income.

Our list of mistakes doesn’t end there. We remain largely ignorant about our 401(k) contributions. Consider the dollar-for-dollar match. If an employee contributed $2,600 a year, he would effectively save $5,200 that year since his employer would contribute an equal amount. So he would double his savings at no extra cost and receive greater returns due to compounding. Only half of all workers save enough to capture that match, though. Or in other words, confronted with absolutely free money, one in two people simply ignore it.

In stark contrast to the overspenders are the oversavers. A 2005 Vanguard annual report on defined contribution plans showed that 16% of participants saved between 10% and 14.9%, while 8% saved 15% or more, which the authors consider to be irrationally saving too much. Those oversavers will go from a lower standard of living while they work to a higher living standard during retirement. They deprive their present and their youth to spend in a future which may or may not happen. Consumption smoothing is more ideal.

Other facts cited in this section:

- Roughly half of older households have never developed a financial plan.
- The average American has a credit card balance above $8,500 accruing 18 percent or more in interest.
- Fewer than two-fifths of Americans pay off their credit card balances monthly.
- Casino revenue surpasses annual 401(k) contributions.
- Some 20 percent of 401(k) assets are invested in employers’ stock.
- One-third of secondary-earning wives are severely underinsured against their spouse’s death.

Chapter 7: Understanding Financial Disease

We ape our parental preferences and behaviors. If your parents were spendthrifts, you tend to become a spendthrift; if they were savers, you will likely be, too. So don’t despair – if you’ve recently maxed out your credit cards, it may be your parents’ fault! (Sarcasm mine).

When it comes to personal finance, we tend to take advice from our parents and friends and/or rely on our personal judgment. The problem with relying on someone else’s experience is that it doesn’t necessarily reflect our own situation. The rich often rely on financial planners, software or even financial publications. But none of those help much, either.

(Note: I agree most online calculators are of limited value, and I tend to think of the financial media as peddling porn for investors. But the authors tend to lump all financial planners together with brokers, tax collectors and record company executives. You know, the real scum of the earth. I think this is shortsighted. My experience is that fee-only planners are a breed apart. I think everyone should use a fee-only planner to make sure the advice they receive is free of all conflicts. The authors whiff on making this distinction. Go to NAPFA.org to find a fee-only planner near you.)

Sometimes it’s just simpler to let others handle our financial decisions. It is certainly easier to let our employers and the government save for/invest for/insure us. And, naturally, they have our best interests at heart. Or do they?

Look back at Enron employees. When the company was on its way to bankruptcy, 11,000 employees collectively lost $1 billion in assets along with their jobs. This happened because they had invested almost two-thirds of their 401(k) assets in the company’s stock. To make matters worse, Enron prevented its employees from selling the stock when its prices were crashing.

Despite the Enron debacle, today over 5 million American workers still have three-fifths of their retirement assets invested in their own company’s stock.

This is bad.

Compulsive behaviors like shopping or gambling are also enemies of consumption smoothing. Just as there are compulsive spenders, however, there are also compulsive savers. In either case, no amount of persuasion can change old habits. One wife may save compulsively because she is unaware of her husband’s earnings. Another may overspend because she thinks she can afford it and her husband is too embarrassed to tell her otherwise. You’d be surprised how often a lack of communication between couples derails the goal of consumption smoothing.

Chapter 8: Financial Snake Oil

Core to the process of retirement planning is usually the concept of the retirement income replacement rate, or replacement rate for short. It says that most people, upon retirement, will need a certain percentage of the income they had earned immediately before retiring. So if you are earning $50,000 at age 65, a replacement rate of 70% to 85% means you’ll need $35,000 to $42,500 in your first year of retirement.

Replacement rates as used by Wall Street, however, typically assume that most of your pre-retirement expenses continue post-retirement. They assume continuation of mortgage payments and perpetual spending on children and college tuition. Most methods of determining replacement rates are made assuming no change is made in your household demographic composition, or that you never spend your accumulated assets. We know none of this is realistic, however. So what gives?

The authors believe “the con begins” with Wall Street convincing you that a replacement rate as high as 70% to 80% is absolutely essential to your retirement.

How do we save that high an amount? The simple solution is to buy any one of 23,000 mutual funds which attempt to provide higher than average returns. However, reality is a little different.

Most fund managers (80% of domestic actively managed stock mutual funds) fail to meet their benchmarks, but the funds they manage nonetheless increase their expenses over time. It’s a zero-sum game: the greater the expenses charged, the greater the losses to the investor.

Those losses, mind you, are in addition to the already high fees charged by the average mutual fund. Mutual fund investors in fact paid a handsome $39 billion in 2002 to brokers for selling mutual funds to them. That’s an extravagant sum to part with – especially for financial services that add no value.

The authors believe that financial planning as practiced on Wall Street offers most investors only two unattractive choices:

1 – Help financial planners make money for themselves while suppressing your consumption during your most vital years; or
2 – Spend your life in anxiety and fear that your retirement will be a disaster.

The best method of planning to the authors remains consumption smoothing. It looks at your entire personalized picture to come up with your lifetime spending power to help you have the smoothest living standard possible, without exceeding your ability or willingness to borrow.

Lastly, a note on annuities, which I mentioned here were a rotten deal for investors. The authors rip equity indexed annuities, too, on page 103:

While equity index annuity products don’t have explicit expenses as mutual funds do, financial economists have calculated that the cost of this safety [referring to the no-loss feature] is extraordinary. Economists have shown that investors would be better off in a simple portfolio of Treasury securities and large-cap stocks 97 percent of the time. They’ve also calculated that the typical equity index annuity purchase amounted to a transfer of 15 percent to 20 percent of wealth from the investor to insurance companies and their sales forces.

And with annual sales of equity indexed annuities reaching $30 billion a year, that’s a staggering loss for investors.

So keep your eyes wide open. At least until we get to Part 3 next week.